US mortgage rates are rising in a reversal of policy and in the UK welcome to a 50% tax rate but not for who you might think

Yesterday was a day which saw a meeting of the Federal Open Markets Committee and I will discuss it a little later. The reason why I had not mentioned it before is that I expected no real policy change. We also received some updates on the state of the US economy. One of them retail sales was quite strong with the monthly increase between October and November being 0.8% meaning that the annual rate of increase is now 7.7%. Furthermore retail sales have now recovered back to pre-recession levels so this was a strongish report. In addition November producer prices rose by 0.8% and on an annual basis rose by 3.5%. So the FOMC would have reviewed these figures with a smile, retail sales growth and signs of a small pick-up in headline inflation (remember it thinks that US inflation is too low). As the “core” measure of producer prices rose on an annual basis by only 1.2%  and the FOMC emphasises core measures ( a mistake in my view as I have written many times before). it could have its cake almost all ways if it chose! But the underlying theme of the US economy was unchanged and so even on the day we got economic figures implying that the FOMC meeting would not have any policy change.

The FOMC statement

Whilst there was no policy change at the meeting there was a change in some of the language used in the accompanying statement. For those unfamiliar with the process the FOMC produces a statement after each meeting and “Fed-Watchers” examine it closely for nuance and any sign of a prospective change of policy.

There was a reference to the problems in the US housing market where we got this.

The housing sector continues to be depressed.

The reason why this matters is that the last statement only mentioned housing starts so the FOMC is worried about the state of the US housing market and so they should be in my view. I have written before about the forsclosuregate problem and that the market is struggling. The recent rise in mortgage rates will not help going forwards and I will discuss this in a moment. There were also a couple of hints in my view that the FOMC could in future increase its policy actions.

the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment………….measures of underlying inflation have continued to trend downward

As the FOMC sees these as its policy objectives I feel that it is preparing the ground in case further action is required but this is nuance and before then we will have a lot more information on the state of the US economy. As ever there was one dissenter Thomas Hoenig which I raise partly because his tenure on the FOMC is about to end and partly because I admire someone who has the courage of their convictions. One consequence of the end of his tenure is that if you see unanimous votes in future it does not necessarily represent a policy change.

Market Reaction: ten-year yields on US government debt up by one point since the FOMC meeting euphoria

The US Dow Jones industrial average rose by 47 points to 11,476 which is a new high for the year so this aspect of FOMC policy is having a good phase as one of the objectives was a rise in asset prices and we have now had a rise in the Dow of just under 300 points. Going much less well is the plan to reduce longer-term interest rates. In fact this is starting to go very badly. In price terms the US long bond or thirty-year future fell on the day by more than two points continuing recent falls. Its yield is now 4.55% which compares with the November FOMC statement benchmark I established of 3.91% .The situation for the ten-year maturity is even worse as it closed last night at 3.46% compared with my FOMC benchmark of 2.57%. Indeed there is a worse comparison as in the expectations/euphoria around the November FOMC meeting ten-year yields fell briefly to one point below where they are now. This issue must be seriously troubling the FOMC, I know it would trouble me if I was on it.

US Mortgage rates

The corollary of rising longer-term interest rates in the US is that mortgage rates are rising too. If we project forwards the changes that took place ordinary US mortgage rates will be well above 5% and the thirty-year mortgage rate may touch 5%. From the lows of earlier this year this is quite a change and it will have an impact on not only new mortgage borrowing but refinancing/remortgaging too. If you project such a rise into the US housing market and then the impact of a slowing US housing market on the wider US economy then if it should continue ( it appears a solid trend now but markets ebb and flow) it may end up begging the question is QE2 pushing on a piece of string?

On this subject I get challenged on the UK and the fact that for example my argument at the beginning of this year that interest rates needed a nudge higher. It did not take place but my view was for a rise of around 1%. This was for various reasons and the obvious criticism of it as posted in the comments section yesterday is that it would raise some mortgage rates. Part of my reason for believing this back in January was that some now was likely to prevent more later. If we look at the US right now they could hardly be pressing for what is called ZIRP or the zero (short-term) interest rate policy much harder could they? And yet their mortgage rates are rising. In spite of adding 75 billion US dollars of asset purchases a month to policy….

Put another way we are facing a very complex situation in my view where much of conventional economic theory is not working and therefore one sometimes has to be unconventional, more unconventional than central banks have been willing to do. However please feel free to comment if you disagree with me I am only replying to make my point (hopefully) clearer.The quality of the comments is I believe one of the strengths of this blog and there is certainly no compunction to agree with me.

The Euro zone crisis: Belgium

The situation took something of a new turn yesterday with both Spain and more unusually Belgium coming under fire from the ratings agencies. In spite of the credibility problem that the ratings agencies have they do from time to time put their finger on a genuine problem so let me quote from the Standard and Poors statement on Belgium.

If Belgium fails to form a government soon, a downgrade could occur, potentially within six months

This establishes part of the reason why I have mentioned Belgium rarely. Her problems are driven by her politics and I try as much as possible to leave that out of here. Also having dealt with people living there they tell me that political instability and changing coalitions is a permanent state of affairs leading to a degree of ennui. However this has been more pronounced recently and in a time of economic turmoil has led to one or two economic points being asked. For example her fiscal deficit in 2011 is estimated to be 11% of Gross Domestic Product or GDP and her national debt to GDP ratio is around 95%. Added to this she is a country who had to spend a lot of money rebuilding her banking sector. Were she to be located on the Mediterranean I will leave you to draw your own conclusions…… However her political uncertainty at a time of economic problems has begun to worry investors so now even a “core” Euro zone country needs to get its act together, which of course is precisely what it is not doing. Should talk of a split in her between the Germanic Flemish and the less Germanic Walloons go further we might get our own bit of the Med on the Channel coast.

The current rescue system of the European Central Bank buying government bonds would not help much here as if rumours got about that it was supporting a core Euro zone nation like Belgium the situation would deteriorate at a stroke. To quote the Alans Parsons Project ” Damned if you do, damned if you don’t” would be the prospect for the ECB. Also with the disputes in the ECB over this policy there would be the risk of a lot more dissent  and even possible resignations at intervention on the scale that would be required. However you look at it last night ten-year Belgian government bonds closed at a yield of 4.08% more than one point over Germany’s. In the heady days following the shock and awe rescue package of early May the spread was more like 0.45%.


There had been a difficult treasury bill auction for Spain yesterday which put markets on the back foot. She had issued both twelve and eighteen month paper but had to pay interest-rates of 3.45% and 3.72% respectively both of which were more than 1% higher than the last time she did so. I have written before that shorter-dated yields are very revealing on the basis that they are the last ones a government loses its grip on. In a bad accident of timing she is issuing some longer-dated paper today and worries about this led to her ten-year yield going to 5.5%.

Accordingly when Moodys rating agency said that it was putting Spain on review for a possible downgrade it probably just about finished off a poor 24 hours in Madrid. Also the reasons behind it were on this occasion mostly things which had been debated on here for some time. for example to say that Spain has a lot of funding to do in 2011 is an odd thing to raise in mid-December 2010! Where have you been Moodys? Is the obvious response to that. In addition the report raised familiar themes (on here) of the cost of recapitalising Spain’s banks being higher than forecast and fears over Spain’s governments ability to control spending in the various regional and local governments (who comprise well over half of Spanish public expenditure). Traders are likely to have greeted this report with the cry “Mafeking has been relieved”, in case you are wondering the siege of Mafeking was lifted in 1900!

Be that as it may such reports do damage even if they could have been written some time ago and part of the reason for this is that Spain is genuinely vulnerable. The bond purchases by the ECB in Ireland and Portugal had also helped stabilise the situation in Spain too but the initial effect had worn off and her yields were rising and prices falling for several days before this. You could if you were so minded accuse Moodys of kicking a nation when it is down.


Moving onto Ireland we get the vote today in her Parliament or Dáil on the bailout from the EU/IMF. There is a big implication from this for me. It is not to recommend that they should vote yes or no but because of the fact that the situation is still unknown and undefined in particular with relation to Ireland’s banking sector one cannot vote rationally in my view. Accordingly they should all abstain until more information is revealed such as the secret side letter about Ireland’s banks. It is my opinion that we are in danger of a yes vote now which is unraveled in 6/12 months time when the full facts are known. That is a worse prospect that finding out all the facts ( as far as one can now).

UK inflation and taxation

I am interested in readers views about the level of UK inflation. I am asking this because in my own expenditure pattern I have seen certain instances of quite considerable rises recently and wonder if I am alone or others have spotted this.

Moving onto the consequences of this I have a thought for you. My brother works as a driving instructor. With the rises in petrol prices which is a big business expense for him his income is reduced but the government via the way it taxes it gains. So in a small way the fiscal deficit is reduced as tax revenue rises but those whose business involves buying fuel have simultaneously inflationary and deflationary forces hitting them.Just to ram it home someone working in these industries has quite a high marginal tax rate if you do the maths. As ever I have and welcome for some people to a 50% tax rate…..But not perhaps for who you expected.


21 thoughts on “US mortgage rates are rising in a reversal of policy and in the UK welcome to a 50% tax rate but not for who you might think

  1. Great blog again, Shaun. It almost makes one’s head spin to see so many topics covered in one day. With serious problems in the US, Belgium, UK, Ireland and Spain (ignoring, for once, Portugal) highlighted above, do you think that we will soon reach some sort of bondholder fatigue?

    • Hi James
      Thank you for the compliment. Actually rather ironically I had been working to reduce the size of the posts just as events have got moving again! As to bondholder fatigue there are real dangers of that and we may have seen the beginnings of it over the past ten days. It is something that has bothered me for all of 2010 but for the middle months rather than fatigue we saw enthusiasm. As I recorded at the time it escaped me who exactly wanted to buy bonds at those yields? But I guess bubbles are always like that and as markets ebb and flow we cannot yet be sure it is over merely that a new phase has begun.

  2. James Noble: “ignoring, for once, Portugal”.

    ZH: “Of note, a particularly weak 3M €500 million Bill auction in Portugal which came at 3.403%, up 159 from prior, with a lower bid to cover: 1.9x vs 2.2x before”

    Apparently the Portuguese felt neglected and in need of attention..

  3. Shaun,

    A couple of thoughts. Firstly, that the BBC has reported that Moody’s believe that Spain won’t default, so it begs the question, if they don’t think they will default, why put them on “watch”? They appear to be a law unto themselves.

    And secondly, I agree with you, living in the UK, that I too feel that a large number of my everyday expenditures have increased over the last year to 18 months. I can’t think of one item that has decreased in value.

    Finally, I too used to be a driving instructor, and your brother has my deepest sympathies for the price of petrol. The only saving grace is that I hope he fills up at Tesco and gets his Clubcard points (other loyalty cards are available and I have no investment in Tesco!).


    • Im glad you raised the issue of Tesco Clubcard points. Along with the, already mentioned, price rises there are other ways of squeezing every last penny from the consumer. Tesco, for example, just last month cut the number of points available over many products (including fuel) and also dropped the value of many of their clubcard “rewards”. I am also probably not the only Tesco customer who has noticed the massive drop in the number of “money-off” coupons and cut price offers inside the store.

      Another favourite in stores (and not just food retailers) appears to be any attempt to reduce value/quality/quantity rather than raise prices. There probably is an economic term for this type of Product vs Price manipulation but in my novice eyes it is still relevant to this discussion.

      Going back to the discussion on Euro debt. Does anyone know of a reliable web source for figures on Euro debt for 2011, both the amounts to be rolled over and estimated new debt? I can find individual country by country examples but not one single source for all. I have to say from what I have seen so far some of the numbers look scary.


  4. “Put another way we are facing a very complex situation in my view where much of conventional economic theory is not working and therefore one sometimes has to be unconventional, more unconventional than central banks have been willing to do. However please feel free to comment if you disagree with me I am only replying to make my point (hopefully) clearer.The quality of the comments is I believe one of the strengths of this blog and there is certainly no compunction to agree with me.”

    Shaun, surely it is not so much that conventional economic theory is not working and that the unconventional is necessary to correct the problems, but more that traditional economic theory is working effectively, demonstrating that parts of modern economic theory do not work in reality?

    I feel that some of the problems have been brought about by the failure to observe, accept and understand economic errors from the past, and similar mistakes have been made all over again as a result. This is partly, I feel, because modern economists have tried to overturn some traditional economic theory; that is largely because traditional economic theory did not include what are now almost obligatory compassionate and welfare and near full-employment components, because these do not naturally exist in the hostile world in which we live? Modern economists seem to have deluded themselves and governments into believing that you can have it all without paying the price; that sufficient real wealth does not have to be continuously generated to pay for what society wants.

    It seems to me therefore that what is actually taking place at present is that natural and traditional economics is “forcing” an economic correction. What modern economists and politicians are trying to do is to counter this natural enforcement, but all they are really doing is delaying the inevitable economic correction. The very printing of excess fiat currency to pay for government debt and calling it “QE”, instead of the debasement which it is, accompanied by an artificially low base rate way below inflation, is an example of these errors!

    At the end of the day we can only share out the real wealth which we generate. For a while we can borrow and try to deceive ourselves, but eventually the water of real economics will find its own level, and there will be nothing which can be done to contain the flood. We thus all have to face up to the fact that much as we may want a comprehensive welfare system and the benefits of mild Socialism, we can only afford that if we generate the real wealth to pay for it all. For some long while most Western countries have been enjoying a level of public spending and paid employment which cannot now be sustained. The issue is really about where the large cuts necessary must be made. Western governments do not want to make any real overall cuts in public spending, because this loses them votes. So they will not do what is necessary until there is economic collapse. Traditional economic theory will then have its way again.

    • I must say I have more agreement with you general comments than your specific which blames the current malaise on mild socialism. Do you not think rampant capitalism should shoulder most of the blame? It was they who created money to support consumers and it was rampant consumerism that led to a massively indebted US and UK. Even more frightening, a huge fraud was perpetrated on some financial institutions who bought poisonous debt rated by the likes of Moodies as AAA.

      • Hi Robert,

        I was not actually citing what was the precipitator for the present problems. I was taking a wider view. I would agree that greed in the form of rampant unregulated capitalism which had escalated out of rational bounds was the immediate precipitator, but that was only possible because the system was already unstable and unsustainable. To a large extent such rampant and reckless gambling in the Financial Sector which led to the present problems, particularly with unregulated derivative instruments based on sub-prime mortgage loans, had been condoned in the mistaken belief that it could replace real wealth generating activity in Western economies, which had been lost. It has begun now to come down like a house of cards. That mistaken belief at political level was similar to the erroneous belief in Zimbabwe that their economic problems could be solved by printing more currency.

        Capitalism generically can only work successfully where there is honour and professionalism. That was for example the fundamental reason for the original success of the City of London. Once honour and truth is no longer the norm, and greed takes over, then only collapse can follow.

    • What do you mean by “natural and traditional economics”? I assume you may mean the Austrian school.

      As to the neokeynesism leading to the recession, that assumed no more boom or bust, then yes that should be burnt.

      • Hi Fletch: By “natural and traditional economics” I meant the natural laws of economics which exist in the real world. As ChrisSW comments later, economic theories are just that – only theories. If you go back a few decades traditional economic theory was fairly well established, and pretty well proven over a number of centuries; but the established constraints did not fit well with the changing political trend. In economics as with all other scientific and quasi-scientific arenas we have the process of hypothesis followed by empirical proof through to the establishment of formal laws and theories. I would agree that the so-called Austrian school holds more traditional and well proven values.

        Just as one example: back in the early 50s inflation was well defined, and in a fiat currency system it was well-known and well-accepted that, since there was no tangible real datum, if a government printed more money or issued more monetary value in any other form, where there was no matched increase in the quantity of real wealth being produced in the economic system, it would generate inflation. Then along came a new generation of “economists” who argued that this previously well-established relationship was not true; that it was much more important to maintain full or near full-employment, and rising prices (and inflation) were good, since they stimulated an economy! Since then we have had rampant and continuing inflation backed by fraudulent official inflation numbers, as governments used inflation to part fund their deficits. The reality of inflation actually destroying the real wealth creating process has been overlooked and discounted, but it nevertheless still goes on in the background because natural economic law still persists! Then we had the invention of the term “QE” to attempt to cover up the reality that issuing more money form causes inflation!

        The balance is not between Capitalism and Socialism, whichever you may prefer. That is not the point which I made. The balance is between paying for public spending by a proper level of taxation or deceit in not taxing sufficiently to pay for it. Politicians in a democracy ultimately shy away from taxing sufficiently to pay for what they profligately waste, because that would lose them votes and consign them to oblivion. They thus indulge in games of deceit and conjuring to avoid losing the votes which they deserve to lose by their profligacy, fraud and corruption. In this case the decision to bail out their Bankster mates and to incur such an unacceptable level of public debt, particularly where it would not solve the underlying problem, which would recur, was a grave error which precipitated the present crisis. It would have been much more sound in the UK for example to have let insolvent banks go bust as with Lehman Bros., and to have used the FSCS to recompense depositors.

        That is what has led us to the economic morass which we now face. I believe we now face a further 2nd round of bank insolvencies and a Depression MkII.

  5. ‘’in my view where much of conventional economic theory is not working and therefore one sometimes has to be unconventional, more unconventional than central banks have been willing to do.’’

    Sorry but I couldn’t agree more!

    As for personally felt inflation of course fuel prices play a major role. We have seen ‘inflated ’prices by mainly food manufactures reducing the contents of packets now we are seeing out and out price rises even on those.
    Last week I went to our local branch of the UK’s the largest supermarket chain to pick up half a dozen things. Being of a generation who doesn’t need a calculator for basic arithmetic I knew how much the bill should be. When I was asked for a different figure I questioned the bill. One of the items which was shelf marked at 43p was now 50p according to the computer. The cashier apologised for the mistaken shelf price but was less forthcoming when I asked of this was in anyway indicative of food price inflation within the store, being an almost 20% price rise!

  6. Great overview again, Shaun. Cost-pull, demand-pull v. money supply…none of this stuff gives me any clear answer – I look around the UK economy and I see an environment where imported goods and commodities are more expensive and we depend too much on these. Investment-grade corporations have access to artificially cheap money and can protect their margins against consumers who are taking the hit through lower real wages and part-time working. I also see monopolistic providers of energy, transport and financial services who exert pressure on price of essentials worrying only about regulators who might say something now and again. Add to this austerity measures pushing on indirect taxation and increasing real credit costs to non investment grade companies and households and you have what we have now.

    Just not sure how raising short term interest rates cures the problem – worried it adds to it !

    • Hi Shireblogger
      I understand that many will think I am proposing a solution which may add to the problems facing us so let me try to explain at least part of my thoughts. Firstly it is by no means a cure but it is part of a solution I believe for the following reasons.
      1. I discuss a range of interest rates because although many only discuss shorter-dated ones ( if you take it literally the MPC only controls overnight rates). Accordingly for me I might raise rates at the shorter end to hopefully help prevent rises in longer-term ones.
      2. the credibility of the MPC would have been improved.
      3. I would combine it with a campaign against the way that many interest rates faced by consumers and businesses have no relationship to it. For example I feel that banks are being allowed to profiteer at this time.This might mean that for some rates would fall, for some borrowers I hope it would. A side effect would be to reduce bank profits (and bonuses) some of which are being earned too easily.
      4. It would rebalance the situation to some degree between savers and investors.
      5. The borrowing situation has been distorted with those on longer-term tracker mortgages in great shape financially whereas those who want one now may not get one at all. It would help here
      6. Money markets would function more efficiently as we move out of what Keynes called the liquidity trap.
      7. It would help end us having an emergency interest-rate when we are no longer in an emergency.
      8. It would aid a rebalancing between savers and debtors.

      So it would be part of a step by step strategy and if you look at events since I proposed it at the turn of the year I feel that inflation trends (which I expected) and economic growth trends (which have been higher than I expected) have backed it up. It would require other things such as reform of our banks which I often call for. Instead they get bailed out again and again.

      But it would not help with oil or commodity price rises in themselves…….. There is, in my view, no magic bullet merely that some choices are better than others.

  7. shaun,

    all economies are driven by energy, and its not cheap anymore. Not for in the UK. increasingly we will compete with Chinindia for Oil and gas on the open market . They will out bid us. Our balance of trade will get worse so we’ll print more QE.

    and whats left of our gas is sold to europe in the summer cheaply , then sold back to us in winter for a handson margin – thats the so called free market for you!

    we live in interesting times


  8. I’m not an economist and hesitate to comment on economic theories other than to note that they are theories. It seems to me that real people tend to adopt an economic theory (or ideology) and then reality tests it to destruction.

    In the present case, I can agree with DRF that we can only pay for “mild socialism” out of what we earn, without seeing “mild socialism” as the proble. That would lead me to conclude that we should stop paying for welfare, health care etc rather than trying to earn more.

    I am more inclined to the view that the problem is a particular form of capitalism which fails to equate credit with debt: or to differentiate between wealth (accumulated past income) and debt (anticipated future income): and a model believing that an economy can be built on demand (consumption) rather than prpduction . Since the 1980s, this ideology has been the received wisdom across the political spectrum and the consequences are now becoming apparent.

    We have all believed we were getting richer because we were taking out bigger mortgages. It was considered OK to out-source production to the third World and to watch as real wages declined here at home. It was thought that the gap could be filled, forever, by borrowing.

    The real question, as between socialism and capitalism, is who did this idealogy benefit. Not the home-owner who is living in the same house with a bigger mortgage: not the worker who’s secure job is now in China: so maybe this is not a socialist ideology. The main beneficiaries appear to be the lenders who profited from the expansion rather than the borrowers who are paying for it (initially through interest payments and now also through taxation).

    In our modern World, it seems to me that lenders equate to capitalists and borrowers to socialists.

  9. What is the purpose of a political and economic system? in my opinion both have to strive for the benefit of the citizens. If the system works for a small selection of people alone, it is not fit for purpose. Pure and simple. Communism generated corruption without checks and balances, led to financial hardships, dictatorships and naturally collapsed. If the current form of capitalism which does not seem to be beneficial to the people generates a dictatorship of the markets which interfere to the democratic will of the people, to their prospects for a better life, then it will also collapse. Ultimately, who is the arbitrator of all, is the banks? no, is it the political elit? no. It is the people themselves, if they stop believing to the system, it will sooner or later collapse.

  10. Hi Shaun,

    Why don’t you start your own basket of goods? This may highlight how agflation is being passed on and you seem to say that all measures of inflation are flawed why not add another flawed one.

    I pretty sure I heard on money box live some statisticians are developing complex measures of inflation for various uses, for example pensioner costs. Using that example surely that is the fairest way to link pensions.

    I am not sure in general anyone notices small price increases so the only levels public talk about are house prices and petrol prices.

    • Hi Fletch
      If I started one I would be trying to make it as flawless as possible! I realise that this isn’t always the game these days…

      As to age related costs I wrote recently about Age Concerns Silver RPI for pensioners which was an effort although as far as I could tell it did not seem to allow for healthcare enough but maybe that in the UK is the impact of the NHS.

  11. Hiya.

    Inflation? Don’t get me started. What puzzles me is that the Keynesians running the monetary system, who as Keynesians should be obsessed with maintaining the demand side of the economy, are also so paradoxically relaxed about inflation!

    Prices of goods go up = people are less able to afford them = lower demand. It’s not rocket science.

    So, The Bank Of England’s policy doesn’t make sense even at the Keynesian level!

    Conclusion: economic policy is being conducted to make us pay more to bail out the elites, not make our lives better.

    Not that that’s news or anything.

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